The Dollar Problem: Emerging Markets Count the Costs

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LONDON — Hardly recovered from a two-year COVID crisis, emerging markets are now facing capital flight, inflation and even defaults as the dollar’s run to two-decade highs tightens the screws.

Almost all past crises in emerging markets have been linked to the strength of the dollar. As the dollar appreciates, developing countries need to tighten monetary policy to prevent their own currencies from falling. Failure to do so would worsen inflation and increase the cost of servicing dollar-denominated debt.

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Despite all the improvements of the past decades, these equations still largely hold and the recent dollar rally leaves a trail of destruction in its wake.

Soaring commodity prices are another complication, alongside a falling Chinese yuan – an anchor for Asian currencies and commodities.

“The cracks are widening. When a strong dollar intersects with high commodity prices, it’s not strange that we have problems in emerging markets,” said Manik Narain, head of emerging markets strategy at UBS.

“And when the yuan weakens, there are no winners in emerging markets.”


The appreciation of the dollar has sent the emerging currency index down 3.5% this year to an 18-month low, although this masks larger losses of 9-15% in currencies such as the Polish zloty and the Turkish lira. Losses also increased in April, coinciding with the decline of the yuan.

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Flexible exchange rates protect developing economies against a repeat of the crises of the 1990s.

At the time, a surge in US currency and Treasury yields first sparked the “Tequila” crisis in Mexico in 1994, then sending shockwaves through Asia, Russia and Brazil. while the parities of the dollar collapsed one by one.

But a stronger dollar still means higher imported inflation, especially given the 30-40% increases in food and oil prices. Currency declines have also likely helped precipitate recent outflows of emerging market investment.

As recessionary concerns spill over into global markets, the bright spot this year is commodity-exporting Latin America. The copper-dependent Chilean peso gained 8% in the first quarter, only to fall 10% since then.

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Central banks in the developing world have raised interest rates by hundreds of basis points cumulatively to keep inflation under control and ensure a sufficient inflation-adjusted bond premium on the rise in US yields.

As a result, emerging economies may grow by only 4.6% this year, according to World Bank forecasts, compared to an earlier forecast of 6.3%.

The strong dollar can also dampen growth by tightening financial conditions – an indicator of how easy it is to obtain credit. An index of emerging market financial conditions from Goldman Sachs is near the tightest since 2008, up about 300 basis points this year.


Rising Treasury yields are driving up the cost of capital globally, but are particularly painful for countries that have gorged themselves on dollar borrowing.

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On JPMorgan’s EMBIGD Emerging Dollar Sovereign Bond Index, returns exceeded 7%.

Higher debt costs, along with economic mismanagement and political unrest, have combined to propel Sri Lanka into a full-blown crisis, and the same scenario could play out elsewhere, investors fear.

Rising borrowing rates are also discouraging many emerging market governments and companies from tapping international bond markets. April, usually a busy month for new bond issues, has seen its issuance this year since 2015, with sales of just $6.9 billion.

Trang Nguyen, emerging markets strategist at JPMorgan, predicted a resumption of bond sales, “even if it must come at a higher cost as countries will eventually have to close their funding gaps.”

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The strength of the dollar and the weakness of the national currency translate into higher import bills, and therefore an acceleration of inflation.

While emerging markets started their tightening cycles well ahead of their developed counterparts, inflation has consistently exceeded expectations.

The rates give water to the eyes: the annual inflation in Argentina exceeds 50%, in Turkey at 70%. Even the wealthiest emerging economies like Hungary are experiencing double-digit inflation.

The International Monetary Fund expects inflation to average 8.7% in emerging markets this year, some 2.8 percentage points higher than expected in January.

Turkey, Tunisia, Egypt, Ghana and Kenya are among the countries considered to be at risk, due to their hard currency debt, current account deficits and high dependence on food imports and energy.

“Commodity prices are a key axis of vulnerability and if we see a further rise in oil and food, we could see a growing list (of casualties),” UBS’s Narain said.

(Reporting by Sujata Rao and Karin Strohecker Editing by Tomasz Janowski)



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